Lesson 4

Lesson Topic : Basic Investing

Goal: To introduce students to the different types of basic investments people make. What are they, how do people find them and how are they each similar and different.

Lesson Overview:

1. Class discussion – What do they know about investing?

2. Lecture/Background info – Different types of Investments (lecture or students read a section and share out)

3. Video – Middle School Money Matters Video 8-4 : Basic Investments

4. Math lesson – Review from last lesson - How to calculate simple and compound interest, interest formulas. Capital gains, what are they and how are they calculated.

5. Student work – calculating interest and capital gains. Looking at different investment statements to see what they show.

6. Wrap-up or Extension activity

Class Discussion Questions: Ask students – What is investing? What is an investment? Can students give examples of what they think investments are? (make a list on the board) How do people ‘get’ these investments? Are all investments safe? Are there investments that are considered safe? Are others not safe? Why?

Background Information – What is investing and why do people do it?

Investing is the idea behind using money to make money and has been a pillar of capitalist economic systems around the world. The simplest form of investing involves letting someone (usually a bank) use your money for a given period of time in exchange for an extra payment, this extra payment is called interest. So for example if you deposit your money at a bank, say $1000 and agree to leave it with that bank for one year, they may pay you say 2% in interest, so when you get the money back at the end of the year they give you your $1000 plus an extra $20 so now you have $1020. In turn, during that year, the bank lends your $1000 out to someone else in the form of a loan for say 4% interest, so that person pays the bank $40 to borrow the money for the year. So the bank receives $40 in interest on the loan and pays you your 20$ in interest and keeps the other 20$ for themselves, this is how banks make most of their money as we learned in a previous lesson, this is called the interest rate spread. As a depositor in Canada this simplest type of bank investment is called a Term Deposit, you are depositing a sum of money for a given term (an amount of time), in Canada the most common term deposits are called Guaranteed Investment Certificates or GICs. These types of investments are considered very safe because they are protected by the federal government through the Canadian Deposit Insurance Corporation (CDIC) . This organization helps to gives Canadians a high amount of trust and confidence in our banks and other financial institutions.

Other types of term deposit investments are government savings bonds and treasury bills.

The next type of investments are bonds. We are not going to go into details about how bonds work, but they are essentially debt obligations provided by large organizations and governments to help them raise money for investment. They are still considered quite safe as usually they are only offered by large corporations which are unlikely to go bankrupt in the short term so most of the time people earn their percentage return. In the 1980s however there was a huge increase in what were called ‘high yield’ bonds, later to be known as ‘Junk Bonds’ because many companies went bankrupt and the bonds ended up being worth nothing.

The third main type of investments are equities. These are stocks. What are stocks? Stocks are partial shares in the ownership of companies. In the simplest example you might have a person who owns a store in your town. That store is likely set up as a company with that person as its owner, they are considered to own 100% of the stock in that company. You could even say that this store has one share of stock and it is owned by one person. Next you might have a slightly bigger company, perhaps a car dealership owned by 4 people. You could say they each own 25% of the company or perhaps that there are 4 shares of stock and they each own 1. Perhaps the dealership is not owned equally, partner A put up twice as much money than the other owners, so partner A owns 40% while the other 3 owners have 20% each, so when profit is distributed partner A is entitled to twice as much profit as the other 3 partners. And once you get much bigger than this it becomes easier to divide the company into shares and then have each person own a certain number of shares (which can then potentially be bought and sold by other people, and this is what bigger companies do in order to keep track of who owns what percentage of a company. Anyone who owns stocks in a company is entitled to a share of the company’s profit, called dividends. This is one way people make money by owning stocks. A second way is through what are called capital gains. Capital gains occur when someone buys a stock for one price, but then the price increases, so when they sell it, they are able to sell the stock for more than they paid for it.

Companies become ‘listed’ on the stock exchange as a way to raise capital (money) to expand their business. Once a company is listed on a stock exchange it is considered to be a ‘publically traded’ company, meaning anyone can buy shares in that company if they want to. Most of the big companies you have heard of like Apple, Tesla, Nike, Starbucks are publically traded companies listed on the stock exchange.

Most companies listed on the stock exchange have millions of shares in circulation but keep specific tabs on who owns them. We will learn more about the specifics of stocks and the stock market in the next lesson. One of the most common ways people invest in stocks these days is through what are called mutual funds. These are collections of stocks put together by investments firms. Sometimes they are grouped by industry, you might have a mutual fund that just invests in energy stocks, or precious metals, sometimes they are group by company size or dividend payout and sometimes they just mirror the collection of stocks listed on a stock exchange.

Mutual Funds allow people to invest small amounts of money in stocks and the funds are managed by professional money managers and stock brokers so individual investors don’t have to be quite as knowledgeable about each investment. There are hundreds of different mutual funds available in Canada that comprise thousands of stocks. Every major bank and investment firm generally has their own group of mutual funds that they manage. By being made up of a collection of stocks, mutual funds allow investors to ‘diversify’, meaning they don’t have all their eggs in one basket, as the saying goes. Because they are made up of a collection of stocks, even if one of the stocks goes down, another may go up and the whole fund itself remains more stable than each individual stock. What investors need to remember though, and what is required by law that banks and investment firms explain to their clients, is that mutual funds are still considered investing in the stock market and are not guaranteed. Even though the fund may be diversified, it may still go down and you may still lose money.

As mentioned, there are two main ways people make money investing in stocks – dividends and capital gains.

Dividends are money paid out to shareholders of a company from that company’s profit. In a very simplified example, if you own 10% of a company and that company makes $1,000,000 in profit, you are entitled to 10% of that profit - $100,000.

Capital Gains are the difference in the amount paid for a share of stock and the amount it is sold for. If you buy a share of a company when it is just starting out for say $10 and then that company starts doing very well, the company will increase in value which means that each outstanding share increases in value as well. So in this example, if you held the share for 2 years and after that time it was now worth $50 and then you sold it, you made $40 just for owning that share, without actually having to do anything. Sale Price ($50) minus purchase price ($10) = capital gain $40. If a share price decreases and then it is sold, a person can actually incur a capital loss instead. There are complex tax rules in place for dealing with investment income such as capital gains/losses, which are beyond the scope of this lesson.

Video: MSMM 8-4 Interest, Dividends and Capital Gains

**There are also many excellent YouTube Videos on the subject of simple and compound interest, dividends, capital gains and stocks and investing.

Activity/Lesson/In-class work – Review of interest and How to calculate capital gains

Last lesson we reviewed how to calculate basic and learned about compound interest. Interest rates are percentages so we generally use decimals. Interest rates are almost always listed as annual rates, meaning what you would earn or pay in a year. Last lesson we took it one step further and looked at the compounding of interest and how much of an effect that can have on investments, especially when people are investing larger dollar amounts.

Just think, if you had $1,000,000 in the bank and were able to earn even 3.5% interest on that money, that’s $35,000 a year or almost $3,000 a month, more than a lot of people make at their jobs. This is one of the main reasons the rich-poor gap continues to increase because while the poorer folk are working hard spending everything they earn just to survive and make ends meet, people with $1,000,000 in investments are already earning that much before they even start working which makes it much easier for them to accumulate even more wealth.

But other than interest bearing investments, many people look to equities (stocks) as part of their investment portfolio. Many people these days have their own online stock trading accounts where they can buy and sell specific stocks, but what has become a very popular way of buying stocks over the last 40 years, is what are called ‘Mutual Funds’. As mentioned, Mutual Funds are collections of stocks put together in a group by banks or investment companies, which allow people to invest much smaller amounts in the stock market and also to be able to invest in a collection of stocks instead of just single companies. Any mutual fund you buy will have a ‘unit value’ which is what an investor will pay for 1 ‘unit’ of the fund (sort of like a share but not exactly). The value of the fund will change as the prices of the stocks collected within the fund fluctuate. The fund will also factor in any dividends paid on shares within the fund. Sometimes investors will take these dividends as payments, other times they will be reinvested into more units of the fund for that investor.

Classwork/Activity: Calculating capital gains. Do several examples of capital gains for the class and then have them work through the problems on the supplied worksheet. Review as a class.

Example: Joe buys 20 shares of Apple for $150 per share, the following year he sells them for $200 per share, what is his capital gain?

20 x $150 = $3000 (the cost of his initial investment)

20 x $200 - $4000 (the proceed from the sale of the stocks)

$4000 - $3000 = $1000 the capital gain earned.

Afterwards, show students examples of various investment statements (supplied) and see what kind of information they show. Look for things like portfolio starting and ending balances for the given investment period, the calculated rate of return, what different investments the money is in.

Wrap-up/ Extension Ideas

· Look up the history of mutual funds. When were they introduced? What percentage of the overall stocks on each stock market are owned within mutual funds? Go online to one of the major bank’s websites and look up the mutual fund section, read about the different funds, share out what you discovered.

· Extension project – look up the history of Junk Bonds. Do you think they were an ethical investment tool. Should the financial services industry be able to cook up whatever they want in terms of investment options leaving the investing public in a ‘Buyer Beware’ situation or should there be more regulation of the financial services industry to protect the average small investor?